How Venture Missed Fantasy Sports

Venture Capital has largely ignored a $70 billon dollar industry that almost exactly fits the dominant filters for selecting the best venture deals: Fantasy Sports. Venture-backed deals need to have a large addressable market, network growth effects, and high precision/high volume customer acquisition mechanisms.

Here are the key attributes of Fantasy Sports:

· High scale customer acquisition mechanisms available
· Multi-billion dollar addressable market
· Clear network and viral growth effects
· Mobile application is a must
· Easily delivered via software as a service

Sounds like a clear match, right?

Let me add one more wrinkle to that before I answer. There is a new subcategory of fantasy sports called “Daily Fantasy”. In daily fantasy, players can play for a single day (or week in the case of football), potentially drafting a new team every time. In the traditional fantasy leagues, a player assumes the role as general manager of a synthetic team for the duration of the season (making trades, deciding which players to start vs. sit). In the United States, fantasy sports contests are skill games, and the law allows collecting entry fees and paying the winning general manager with real money.

The collection of these entry fees not only makes daily fantasy “venture fundable”, it makes them “winner take most” businesses, an outcome overlooked by many smart VCs. Fantasy Sports, in particular daily fantasy contests, are classic marketplace businesses. In marketplace business models, buyers and sellers come together and the marketplace collects a fee. When two fantasy players enter a contest or challenge each other head to head, this exact dynamic is in place.

The result is a business with “winner-take-most” economics. The largest collection of players will have the largest amount of liquidity available to players. This liquidity attracts more players and gives the big marketplace the lowest customer acquisition costs vs. less liquid marketplaces. Result: a virtuous circle of gaining share against the smaller competitors, increasing the advantage.

This is the kind of business model that venture capitalists dream about.

So back to the key question: Did venture capital funds understand and make investments in this category? The answer is by and large no. And there were several reasons:

- Even though $10 billion in entry fees are collected EACH year in the United States alone, there were lingering questions about regulatory issues, which I believe have now been clearly settled

- Venture firms viewed this as another “sports business” that could not possibly get big due to the lack of sizable ($1 billion or more) exits in the category

- Many didn’t understand this was a classic marketplace/network effect business and not just another web/content portal

Just this week it was announced that $70 million dollars has been put into a Bullpen investment: FanDuel. The round was led by Shamrock. Heavy hitters like KKR, Comcast, and NBC Sports participated in the round. You can read more about this investment here:
http://dealbook.nytimes.com/2014/09/02/fanduel-an-online-fantasy-sports-site-raises-70-million.

Competitors in the space have recently raised significant capital as well. And the industry is rapidly consolidating down to just a few big players, which is what we expect in a winner-take-most business. These businesses have now hit the mainstream. You can see advertisements during ESPN programs, on the radio during baseball games, and all over digital channels as well.

The lesson here is that is sometimes VC Funds miss an obvious venture category. It leaves the early stages of proof of such model to smaller funds like Bullpen. As a result the bigger players come in later (also consistent with their much larger fund sizes). Venture, for better or worse, tends to be a herd mentality business. Being contrarian is frequently not rewarded; but at times springs a huge victory for being on the trendline before the herd sees it

So, for a short period time right now, I get to have the fun of my phone ringing with the question: “why didn’t you show me that deal earlier.” To which I can reply, “I did, but you said NO, don’t you remember?”

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